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Abstract
The blanket guarantee introduced in 1998 in response to the emerging banking and economic crisis resulted in $50 billion of losses to the general public. The government has now introduced a law that allows the phasing out of this blanket guarantee, but also allows its reinstatement in the event of a threatened collapse of the banking system. Rather than eliminating the possibility of any repetition of the previous banking disaster, the new law effectively mandates an almost identical approach to handling system-wide banking collapses in the future, suggesting that the authorities and their advisers learned very little from the recent bitter experience. It is argued here that the crucial starting point for formulating policy in this field is to specify correctly the exact purpose that government intervention is intended to serve: namely, the avoidance of major macroeconomic disruption as a result of bank failures.
Notes
1 Marshall (Citation1994: 193–8) provides empirical evidence, however, that in the absence of deposit insurance in pre-crisis Indonesia sufficient numbers of depositors did appear to differentiate among banks across and within ownership groups (state, foreign and private– domestic) on a variety of risk indicators. This resulted in a structure of deposit interest rates that differed significantly among these groups, so small depositors were compensated for higher risk even if they did not personally perceive it.
2 A further consideration leading in the same direction is that it is now understood that monetary policy can be used to offset sudden declines in system liquidity as a result of runs on banks. However, recent experience in Indonesia shows that this can be extremely expensive to the government, as we shall see.
3 By far the majority of countries with deposit insurance schemes restrict coverage to ‘small’ depositors, though the monetary amount that defines ‘small’ differs very widely. Note, however, that roughly half of the 182 countries contained in the World Bank's deposit insurance schemes database (Demirgüç-Kunt et al. Citation2005) do not have explicit deposit insurance schemes. High-income countries in this category include Australia, New Zealand, Hong Kong and Singapore.
4 The CAR is the ratio of capital to risk-weighted assets.
5 Understandably, perhaps, the government of the day chose not to report a budget deficit of the order of 40% of GDP, although this is exactly what was implied by the bailout.
6 The decision to set the rate at 0.2% appears to have been essentially arbitrary. Such premia vary enormously around the world (for example: India and Korea, 0.05%; Ecuador, 0.65%) (Demirgüç-Kunt et al. Citation2005).
7 This and other translations of parts of the law and its elucidation are by the author.
8 The logic here is confused. The introduction of moral hazard as a result of deposit guarantees is actually likely to harm the health of the banking sector, even though the guarantees may protect it from disruptive bank runs.
9 In making this observation it is not intended to argue in favour of abandoning regulation and supervision—an issue beyond the scope of this paper—but merely to warn that it would be foolhardy to rely on it too heavily.
10 Interestingly, there is no formal, specific reference to this in the list of relevant laws and regulations that always precede the text of Indonesian laws. Presumably the reference here is to the presidential instruction issued in January 1998, announcing the blanket guarantee.
11 Alternatively, such cases may be referred to the LPS by a high-level coordinating committee, discussed in more detail below.
12 Recall, however, that there is a phasing-in period during which larger deposits are guaranteed.
13 A further element that distorts the choice between rehabilitation and liquidation (not shown in the table) is the fact that the law defines the cost of rehabilitating a failed bank to include the additional capital needed to raise capital adequacy from zero to the minimum level stipulated in the regulations [art. 23 (1)]. In fact, additional capital injections to generate positive equity are an investment, not a cost.
14 It is surprising that this crucial term is not defined in the law. The interpretation given here is obtained from a reading of the preamble to the elucidation of the law.
15 The law actually states that the committee's membership is comprised of ‘the Minister of Finance, the BSI, BI, and the LPS’ [art. 1.9].
16 There is provision for the existing shareholders to participate in the rehabilitation, subject to their contributing at least 20% of the required equity injection.
17 This amounts to a significant market distortion, providing a competitive advantage to large banks. If depositors are aware of the distinction between systemically important banks and the rest, they will either shift funds to the former, or demand a higher interest rate to keep funds with the latter.
18 This appears to require the agreement of the parliament; to this extent, the solidity of the guarantee is compromised.
19 According to Fane and McLeod (Citation2002: 288), the net fiscal cost of the bailout was about Rp 384 trillion, while total bank deposits were only Rp 283 trillion in mid-1997.
20 This figure is calculated as total bank liabilities (excluding equity) in June 2004, divided by GDP in 2004.
21 The government's concern to protect depositors against losses incurred as a result of holding commercial bank liabilities is not matched by a similar concern about those resulting from their holdings of a liability of the central bank: namely, cash. The authorities have a rather sorry record in this regard. For example, the value of cash fell by half in the first nine months of the recent crisis as a result of poor monetary policy.
22 State-owned banks in Indonesia have a collectively miserable record of failing and being recapitalised by the government, at tremendous cost to the public. They have played a far greater role in the economy than would have been possible if they had been subject to the unforgiving discipline of the market.
23 Privately provided deposit insurance is a rarity, although not totally unknown. Beck Citation(2001) describes a scheme that has been operated by the private commercial banks in Germany since 1975. He argues that ‘the scheme as a whole cannot be easily transplanted to other countries, [but that] there are still several lessons to be learned, especially for developing countries’ (p. 25).
24 Presumably it is for this reason that the new Indonesian legislation initially imposes a common guarantee premium for all banks, and restricts any future gap between the highest and lowest premium to just 1% p.a. There is no obvious economic rationale for such a restriction.